Hot Off the Web– January 19, 2010

Personal Finance and Investments

Jason Zweig’s WSJ article “Why many investors keep fooling themselves” writes that many investors (and advisors) are dreaming in Technicolor. He reminds readers that on a net-net-net basis (i.e. after inflation (3%+), expenses(2%) and taxes) US stocks returned about 4% annually; and if “you mix in some bonds and cash, your net-net-net is likely to be more like 2%.” He says that: “I asked several investing experts what guaranteed net-net-net return they would accept to swap out their own assets. William Bernstein of Efficient Frontier Advisors would take 4%. Laurence Siegel, a consultant and former head of investment research at the Ford Foundation: 3%. John C. Bogle, founder of the Vanguard Group of mutual funds: 2.5%. Elroy Dimson of London Business School, an expert on the history of market returns: 0.5%.” (No doubt you heard this before if you read some of my blogs on the subject; e.g. Planning)

The Globe and Mail’s “An investor’s personal roadmap to wealth” explains the importance and value of an Investment Policy Statement (IPS), which is a ‘road map’ to your financial life. A good IPS covers your objectives, risk tolerance, constraints (horizon, taxes, etc), asset allocation, income requirements, benchmarks, return requirements to achieve objectives, capital market expectations, and resolution of conflict between needs/wants and (realistic) return expectations and etc. If you are paying for advice (implicitly or explicitly) and you don’t have an IPS, you might consider changing advisors. Heinzl, by the way, also points out that “an IPS should clarify the relationship (between you and your advisor) so that both parties have similar expectations”. (You can read more about the IPS under the Asset Allocationtab at this website.)

In the NYT’s “For financial advice, arriving at the right dosage” Tara Siegel Bernard discusses the whys and hows on choosing a financial advisor. She argues that what you need depends on your life stage; a young graduate has different needs than somebody just ready for retirement. Also “You may need only some straight-ahead advice on how to invest your retirement money, or you may really want someone to make sure you stick to your plans — the equivalent of a fiscal trainer.” (i.e. investment advice and/or life coaching?) “Even the most die-hard do-it-yourself investors could use a second opinion, and everyone could use a periodic checkup to be sure they’re on track. Major life events may call for a change in plans, but not necessarily a full-time financial steward.” If you are interested in the ‘advisor’ topic the you might want to also read the Financial Post’s “How to select a financial advisor”. (Also, don’t forget the importance of an IPS discussed in the previous article mentioned.)

In the Financial Times’ “US leads the way as ETF assets surge” Henny Sender reports that U.S. ETF assets passed the $1T mark at year end 2009. Reasons for their popularity are: cost, liquidity, disillusionment with active management, easy access to different asset classes and easy implementation of desired strategic or tactical asset allocation.

Tim Cestnick’s Globe and Mail article “Trading liquidity for certainty with an annuity” advocates the use of insured annuity, i.e. buying an annuity and a life insurance at the same time (for those insurable at retirement age), as a means of increasing after tax income, securing income for life and still leaving something for the estate. (I am not convinced that this is a good solution due to a combination of reasons: cost, liquidity, validity of high tax-rate assumption for a couple with $400K assets, impact of inflation, use of 100% GICs/T-bills as benchmark, implications on the quality of insurance company which pay over 8% for a joint annuity for 70 year olds when the payout range available from other companies appears to be 6.6-7.4% at this time (e.g. CBonline), or for that matter the wisdom of locking in an annuity in such a low interest environment with such a high risk of increase in inflation/interest rates.)

Chris Sorensen’s article has the great title “The great unknown: Retiring comfortably requires big savings. How much is enough?”Unfortunately, the closest he comes to an answer is quoting Jim Otar that for a 65 year old $300K is needed for each $10k of income expected to last at least 30 years. Other than that the usual quote from actuary Hamilton that 50% of pre-retirement income is enough whereas typical financial advisor recommendation is 70%. (Of course what you actually would like is to at least be able to maintain your pre-retirement standard of living (spend rate) and or ideally increase spend rate given that in retirement you have time for some leisure and travel. In any case, using pre-retirement income is completely the wrong way to tickle required post-retirement income requirement; instead you need an in-depth understanding on what are your pre-retirement expenses, what expenses/activities will continue in retirement and what expenses/activities will start/stop in retirement. Once you calculated your estimated after-tax retirement income needs, you can then calculate the corresponding pre-tax income required and an estimate for assets to generate that income.)

In the Herald Tribune’s “Protecting elders from con artists” Lew Sichelman reports that “According to a recent report from MetLife’s Mature Market Institute, the elderly are victimized to the tune of $2.6 billion a year. And that’s a conservative guess because it has been estimated that only one in 25 cases of financial abuse is ever reported to the authorities.” The article then proceeds to discuss the various means of short-changing seniors, directly or indirectly, via reverse mortgages.


A very interesting article in the Financial Times entitled “Pensions: Led into temptation” Norma Cohen discusses how actuarial advice has led to massive losses of UK clergy’s pension funds.”…it was, as in the past, the actuary to which the board listened most. The advice given was clear: the entire CEFPS fund should be invested in higher-returning assets. Equities, the board was told, could be relied on over the longer term to deliver big returns.” You can read on the article discussing actuaries changing previous guidance to the church based on “back of the envelope calculations” not just due to massive losses in assets but also due to large increases to liabilities, “following regulator demands that schemes adopt more prudent assumptions of future investment returns”. In a sidebar Norma Cohen writes that It was an approach that enabled actuaries – professionals who specialize in calculating probabilities – to urge schemes to invest heavily in equities over less risky assets. It also used techniques that made the costs of pension provision appear much lower. There were no clear rules to stop actuaries from assuming long-term high returns on equities that would reduce liabilities dramatically. Deficits could be made to vanish with the stroke of a pen. The profession ignored the mathematical innovations that transformed trading rooms, which might have helped identify the risks of relying on equities to cut the cost of pension promises.”(What a “profession”?!? Actuaries sound like they are in a serious need of some adult supervision. No doubt that if/when a post-mortem will be done on systemic failure of Canada’s traditional pension system (yes, failure, despite the protestations of Mr. Flaherty…just look at Nortel’s pension, as good an example as any), a significant portion of the blame will be laid to the feet of the actuarial “profession”.)

Janet McFarland’s Globe and Mail article “Getting used to living on less” seems to be also quoting actuary Hamilton; except this time he is concerned that Canadian earning between $25K-125K pre-retirement incomes are averaging in retirement only 50% of their pre-retirement income. But this is OK since actuary Hamilton has been repeatedly quoted that 50% of pre-retirement income is adequate in retirement (e.g. “The ABCs of pension reform in Canada”) (People seem to be confused. Retirees don’t need advice on how to live on less, retirement planning/advice should be about how to maximize your retirement income given your level of savings, by reducing all the friction (cost) introduced in the investment/saving process by the financial services industry.) Another brilliant quote from Mr. Hamilton to help(?) the reform of Canada’s failed pension system is “”Because the other half of their pre-retirement income went to taxes, savings, children and mortgages,” Hamilton said. The “genius” of the Canadian system is to “suppress the standard of living of young Canadians during their working lives so they are not disappointed with low incomes when they retire.” (From Chevreau’s “Three in four fee retirement of their dreams out of reach”). With actuarial input like this into Canada’s pension reform discussion, the future of Canadian retirees is secure-Not.

Real Estate

On the U.S. real estate front, in Sun Sentinel’s “Broward and Palm Beach counties see 42% increase in foreclosures” Paul Owers reports that over 100,000 homeowners in Florida’s Broward and Palm Beach counties faced foreclosures in 2009. The expectation is for more of the same 2010. In Herald Tribune’s “20% more Southwest Florida homes lost in 2009” Kessler and Bayles report over 27,000 foreclosure notices in Florida’s Southwest. CNN’s Les Christie reports that in the U.S. “Record 3 million households hit with foreclosure in 2009”; Nevada leads the pack with 10% foreclosure rate, with Arizona and Florida right behind at about a 6% rate.

Canada’s housing problem is at the opposite end of the U.S.’s. Garry Marr in the Financial Post’s “Record house sales revive bubble fears”reports on the debate whether Canada’s housing market is in a bubble. “CREA is still forecasting sales will jump by 7% this year, much of that because the first few months of 2009 were relatively weak. Prices are expected to rise 4.7% (in 2010)….The average sale price of a home climbed almost 103% over the last decade, compared to about a 40% increase for the S&P/TSX composite index. By comparison, the average house price increased just 8% during the 1990s.”

Things to Ponder

In Financial Times’ “What can we learn from Japan’s decades of trouble” Martin Wolf writes that “the rest of the world has to wonder whether it is learning the lessons from Japan’s fall from economic grace. Japan’s experience strongly suggests that even sustained fiscal deficits, zero interest rates and quantitative easing will not lead to soaring inflation in post-bubble economies suffering from excess capacity and a balance-sheet overhang, such as the US. It also suggests that unwinding from such excesses is a long-term process.”

In “Not just another fake”the Economist argues that “China’s boom is unlikely to give way to prolonged slump” despite similarities with Japan in the 1980s. The doomsayers base their arguments on “overvalued asset prices, overinvestment and excessive bank lending”. But Shanghai PE ratios are 28 compared to Tokyo’s 70 in 1989. Average home prices to average annual household income is a very high 10 (but Japan’s was 18 in 1990), but this statistic may be misleading anyway since “Chinese homebuyers do not have average incomes but come largely from the richest 20-30% of the urban population. Using this group’s average income, the ratio falls to rich-world levels.” Also a Chinese debt level on homes is low, since minimum down payment is 20% for owner occupied homes and 40% for investment properties. “Chinese households’ total debt stands at only 35% of their disposable income, compared with 130% in Japan in 1990.” Fixed investment levels of 47% of GDP last year was 10 points higher than at Japan’s peak, and compared to 20% for developed countries. But some argue that high investment does not necessarily mean waste. Bank lending is high and a concern for many observers. There is an interesting chart (#4) of GDP growth rates vs. GDP per person as % of US, comparing China’s situation today with other Asian countries now and in earlier years. “The fact that China’s GDP per head is much lower than Japan’s in the 1980s suggests that its growth potential over the next decade is much higher.”

In the Financial Times’ “Market cap indices face new rivals”Steve Johnson suggests growing competition for market cap indexes from “alternative approaches (that) have emerged in recent years, such as fundamental indices – in which stocks are weighted by metrics such as book value, dividends and sales – and minimum variance, in which portfolios are designed to reduce volatility. FTSE will expand this range today by launching a family of Risk Efficient indices…which aims to deliver the highest Sharpe ratio, a measure of risk-adjusted return.” “John Davies, senior director at index provider Standard & Poor’s said 40 per cent of the money tracking S&P products was now following fundamental indices, although these are mostly indices custom-made for large investors.”

And finally, in the Economist’s “Digging out of debt”, the message is that deleveraging has just started and history tells us that typically this was accomplished by default, inflation and “prolonged period of belt-tightening”, the latter being the case 50% of the time. “Typically deleveraging began about two years after the beginning of the financial crisis and lasted for six to seven years.” The current situation is perceived as being worse than previous cases because of: higher indebtedness, simultaneous crisis in many countries reduced possibility of export-led expansion, large increase of public debt. “The most painful bits of deleveraging could well lie ahead.”


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